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What are the advantages and disadvantages of an unsecured loan? What should I be looking out for? (Updated 15/7/09)

An unsecured loan is a personal loan that isn't secured against any of you assets. Unsecured loans are considered by lenders to be fairly high risk, so to be approved for one you will need to show evidence of a sound credit history and sufficient earnings to repay the loan.

But how do you decide whether an unsecured loan is right you? In this guide we take you the advantages and disadvantages of unsecured loans, as well as offering top tips on getting the best loan deal.

• What are the advantages of unsecured loans?
• What are the potential drawbacks of unsecured loans?
• Can I repay my loan early if I so wish?
• Our recommendation

What are the advantages of unsecured loans?

Not everyone has a foothold on the property ladder so not everyone is able to apply for a homeowner loan. Unsecured loans allow those who don’t own properties the chance to take out a loan.

However, homeowners may themselves choose to take out an unsecured loan. Unsecured loans do not involve the numerous security measures associated with arranging secured loans, and taking out an unsecured loan can be a relatively simple process, with funds made available within 24 hours in some cases.

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What are the potential drawbacks of unsecured loans?

The lenders’ terms of the loan will reflect the high risk nature of unsecured loans, and characteristically will allow lesser amounts to be borrowed at a higher rate of interest than most secured loans. Interest rates on unsecured loans can be exorbitant in the extreme, so it's essential to shop around.

The size of an unsecured loan will generally be smaller than that of a secured loan. As a result, the repayment duration of the loan will often be shorter, usually no longer than five or 10 years.

It's essential that you check all the terms and condition with a fine-toothed comb before entering into any loan agreement.

It's also important to remember that whether your loan is secured or unsecured, court proceedings will still be brought against you if you fail to keep up with repayments on the loan. Before you take out any loan you should ask yourself whether you really need to borrow the money and ensure that you will be able to meet payment deadlines.

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Can I repay my loan early if I so wish?

You can, but you’ll be liable to pay what’s known as a "redemption penalty"

Effectively, if you repay your loan early your lender will lose money in missed interest repayments, and they will penalise you for this. Check the magnitude of any redemption penalties before signing the agreement as some can be quite large.

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Our recommendation

If you are looking to get the best deal on an unsecured loan, follow our top tips:

• Compare loans to get the best deal – When taking out a loan it is essential that you compare loans to find the best rate available. When comparing loans make sure you look carefully at the APR as well as checking for any additional fees.
• Check your credit report before you apply for a loan – Not only will checking your credit report reveal to you how you look to prospective lenders, it also gives you the opportunity to correct any information that is wrong and give yourself the best chance of being approved.
• Don’t borrow more than you need – While it may be tempting to add a little extra to the loan amount to treat yourself, don’t do it. Borrowing more will cost you even more in interest in the long run, and you’ll likely be in debt for longer, so only borrow what’s necessary.
• Watch out for delivery charges – Some lenders will offer to send a cheque to you by courier or transfer you loan into your bank account the same day. These services will usually attract an extra fee so only pay for them if you really need them.
• Watch out for payment holidays – Some lenders may offer to defer your repayments for a few months at the start of the loan. However, you will still be being charged during this time and your future repayments will be larger to compensate. Your total amount repayable will be larger too, so avoid this if possible.

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